What is Loan to Value Ratio and Why is it important?

When you start to look at mortgages lost of terminology and ‘buzz words’ will be thrown around. Like any area of commerce, people just love inventing their own technical jargon. This jargon can be a time-saving shortcut for the professional dealing with these matters all day, every day, but the downside is potential confusion for the customer.

There are several phrases it’s worthwhile knowing and one of the most important ones when you are trying to establish how much you can afford to borrow is LTV or Loan to Value.

Loan to Value refers to a ratio between two figures, namely the amount of money lent (the loan) and the value of the home you are buying (the value). In most cases the value of the home will be pretty much the same as the sum you have agreed to pay for it, but sometimes a professional valuer will disagree. They might think the value is higher or lower and this is important. We’ll discuss why later.

Mortgage companies such as banks and building societies have strict rules that govern their lending policies. Some of these rules have been imposed by Government after the 2008 ‘credit crunch’ and some have always been in place in one form or another. In simple terms, the rules are set to protect the lender and reduce their potential risk in the event that the borrower stops making their monthly payments. In this instance, eventually, the lender will want to see the property sold so as to get their money back, plus any interest and charges agreed between the parties at the time the loan was made.

In order to reduce the likelihood of this ‘nightmare’ scenario happening, the lender will undertake several calculations based on information received from the borrower and the borrower’s advisors and a mortgage valuer employed by the bank (but paid for by you) to establish the value of the property you intend to buy. The bank will have set criteria for lending based upon your income, your expenses, your job type, credit history, personal circumstances and the Loan to Value ratio (LTV).

The higher the Loan To Value, the less equity there is in the property when the loan is taken out and the riskier the loan is to the lender. For this reason, the higher the LTV, the more expensive your borrowing costs are likely to be. It therefore pays to put down the biggest deposit you can afford to put down if it reduces LTV and the cost of borrowing.

Most lenders require a minimum Loan To Value of 95%, meaning that you need to put down a deposit of 5% of the value of your purchase. The cost of borrowing 95% of your home will be relatively high, especially when compared to a borrower with an LTV of 75%.

Loan To Value is calculated as follows;

Amount borrowed x 100 = LTV in %Value of property

If you are buying a home valued at £180,000 and you are looking to borrow £170,000 with £10,000 deposit, then your LTV is;

170,000 x 100 = 94.44%. This is just enough for some borrowers.180,000

The problem to avoid is to agree to buy a home only to have a mortgage valuer place a valuation on the property lower than the purchase price. In this instance, you may need to renegotiate the price to a lower figure. If the seller refuses to do this, you may have a problem, but remember, do you really want to buy a property for more than it is worth? Most sellers will be reasonable when confronted with a lower valuation.

If you don’t have a large enough deposit, and your LTV is over 95%, don’t worry. Some lenders will offer larger mortgages in certain circumstances and the Government is currently offering buyers of new homes or older housing assistance through their help to buy schemes. Ask us for more details and to see whether you are eligible.

The Financial Ombudsman Service is an agency for arbitrating on unresolved complaints between regulated firms and their clients. More detail can be found on their website: www.financial-ombudsman.org.uk